So what are the governments of the world doing to address this core problem? Breaking up the giant banks? Nationalizing them? Holding them accountable for their criminal acts? Making them write down their bad debts? Reining them in? Making them act more responsibly?

Of course not!

The governments of the world are instead launching more faux stress tests as a P.R. stunt.

Well-known British economic writer Jeremy Warner said last week that the European stress tests were a sham:

European stress tests weren't worth the paper they were written on ...

Most of us said at the time that the tests had been designed for banks to pass, yet the fact is that it is now hard to believe they took place at all. Conditions have no where near deteriorated as far as the tests had assumed, yet still Allied Irish looks essentially bust. In other words the tests were a lie.

If the Irish stress tests were a sham, what about the rest of the eurozone?

As the Wall Street Journal notes today, Europe is launching a new round of stress tests.

"As market sentiment toward the euro zone sharply deteriorates, European officials are planning a new round of bank "stress tests" that they say will be more rigorous than the widely discredited exams conducted earlier this year." Thank you for confirming the prior stress test, the one which found that not one Irish bank was impaired, was a bunch of bullshit. Of course, this being Europe, it will require another forceful intervention by the uber-propaganda czar Geithner to get European countries in line: "But the tests are already subject to bickering between countries. While some European leaders are pushing for next year's tests to be broader and more transparent than last summer's exercise, the agency that will oversee the tests says it might opt not to publicly disclose the results at all." And all will be proclaimed to be fine.

Concerns about the health of most large institutions have decreased, though investors remain nervous about the extent of losses banks face if they are required to repurchase flawed mortgages and mortgage-related investments. As part of its review, the Fed will require banks to assess their exposure to so-called "put-backs" of mortgages

Banks will also have to come up with their own set of metrics, including the ability to withstand "very severe" economic and financial-market events, the Fed said.

We are apparently expected to believe that this time will be different.

But the European and American stress tests will undoubtedly once again use overly-rosy economic assumptions, fail to account for the many trillions in debts hidden SIVs and other off-balance-sheet locations (see this and this) and duplicate the other core errors of the previous tests.

Postscript: Here's a funny Saturday Night Live video on the American stress tests:

"At the moment, for example, we are sitting on 5GB from Bank of America, one of the executive's hard drives," he said. "Now how do we present that? It's a difficult problem. We could just dump it all into one giant Zip file, but we know for a fact that has limited impact. To have impact, it needs to be easy for people to dive in and search it and get something out of it."

I have repeatedly documented the detrimental impacts of dispersants on humans, wildlife and seafood safety. See this, this, this, this, this, this and this.

As I noted in September, scientists from Oregon State University found elevated levels of polycyclic aromatic hydrocarbons (PAHs) in the Gulf, and blamed dispersants.

Now, the website of the prestigious Journal Nature is also reporting on the increase of PAH contamination due to the use of dispersants in the Gulf:

Peter Hodson, an aquatic toxicologist from Queen’s University in Kingston, Ontario, presented his case on 9 November at a meeting of the Society of Environmental Toxicology and Chemistry in Portland, Oregon…

The problem, explains Hodson, is that the dispersed cloud of microscopic oil droplets allows the PAHs to contaminate a volume of water 100–1,000 times greater than if the oil were confined to a floating surface slick. This hugely increases the exposure of wildlife to the dispersed oil. …

Worse, the toxic constituents of oil hang around longer than other components, another speaker told the meeting. “This idea that there’s an oil biodegradation rate doesn’t hold,” says Ronald Atlas, a microbiologist at the University of Louisville, Kentucky, who has studied the aftermath of the 1989 Exxon Valdez spill in Alaska. Alkanes, the simple hydrocarbons that comprise the bulk of oil, are degraded more readily than the PAHs, he points out.

“These chemicals, these are PAHs that are carcinogenic. … These items are not in any way appropriate for anyone to eat,” said Ed Cake, an environmental consultant from Ocean Springs. “There’s no low-dose level that’s acceptable to eat.”…

[William Sawyer], the [veteran] Florida toxicologist, said the government tests do not look for total petroleum hydrocarbons in the seafood. He said his tests of Gulf shrimp have shown unsafe levels of the compounds, which can cause liver or kidney damage in a matter of weeks.

“We’re more concerned about the dispersant and the dispersant mixed with oil–the dispersed oil, if you will–than we are about the crude oil itself.”

Tests conducted in recent months by [University of Southern Maine Center for Toxicology and Environmental Health director John] Wise’s lab, using human cell lines, show that dispersants cause cell death and DNA damage, which has been linked to cancer and reproductive problems.

Brand new laboratory test results just in Monday morning are showing troubling problems with gulf seafood… the results are raising a lot of red flags.

WFTV put gulf shrimp to the test by ordering raw shrimp over the Internet and shipping it to a private lab. …

Scientists found elevated levels of Anthracene, a toxic hydrocarbon and a by-product of petroleum. The Anthracene levels were double what the FDA finds to be acceptable.

The scientist who tested the shrimp said she would not eat it based on the results…

I've also previously reported that dispersants were used long after BP and the government said they had stopped using them in July. Now, Cherri Foytlin and Denise Rednour claim to have pictures of 176 empty containers of ‘discontinued’ COREXIT 9527A found… With a ship date of August 10th. And the president of a county seafood workers' association claims that dispersant is still being applied.

An NSF-funded workgroup notes: “Storms are likely to resurrect the oil that is currently hidden from sight” — “Much oil persists” nearshore

A Florida State University professor says the oil is still there: "most of that Deepwater Horizon oil — as much as 70 percent to 79 percent of it —sank to the ocean floor, where it remains, sucking up oxygen and inhibiting life.

A University of Florida scientist says “clear evidence that much of the oil is still below the surface in subsurface plumes”

Alabama shrimpers find catch “coated in oil” at area open for fishing — Boat to be decontaminated

Instead of cracking down on BP, the Obama administration has granted "categorical exclusions" to federally funded stimulus projects by BP (and other companies), effectively exempting those projects from environmental oversight

Any version of S510 which penalizes small farms and ranches with onerous regulations targeted to the food giants will stifle competition, and drive many small independent food producers out of business.

Democrats Jon Tester of Montana and Kay Hagan of North Carolina have proposed an amendment which would exempt from the new regulation small farmers and food facilities with less than $500,000 in annual sales that directly market to consumers in a 275-mile area.

Many websites have also warned that S510 could - intentionally or unintentionally - interfere with people's ability to grow food in their own gardens. While I have seen no evidence of that (admittedly, I haven't spent any time looking at the issue), people should also demand that the language of S510 be clarified to explicitly exempt home gardens.

Update: Less than 24 hours after I wrote this post, the Senate passed S510, with the Tester amendment included.Thanks to those who called.

France is apparently following the example of Ireland and Hungary and seizing pension funds.

According to eFinancialNews, the French parliament passed a law last week allowing 36 billion Euros to be seized from the French reserve pension fund to be used to pay off the debts of France’s welfare system.

As eFinancialNews notes:

The move reflects a willingness by governments to use long-term assets to fill short-term deficits, including Ireland’s announcement last week that it would use the country’s €24bn National Pensions Reserve Fund “to support the exchequer’s funding programme” and Hungary’s bid to claw $15bn of private pension funds back to the state system.

There have been unsubstantiated rumors for years that the American government will also seize 401(k) money.

Sunday, November 28, 2010

Many of the world's top economists and financial experts have said that the too big to fail banks are destroying the world economy, that they must be broken up in order to restore stability, and that small banks can easily pick up the slack and make all of the loans which are needed needs. See this, this and this.

And yet many people still believe the myth that the giant banks have to be saved at all costs.

All this was inspired by the principle--which is quite true in itself--that in the big lie there is always a certain force of credibility; because the broad masses of a nation are always more easily corrupted in the deeper strata of their emotional nature than consciously or voluntarily; and thus in the primitive simplicity of their minds they more readily fall victims to the big lie than the small lie, since they themselves often tell small lies in little matters but would be ashamed to resort to large-scale falsehoods. It would never come into their heads to fabricate colossal untruths, and they would not believe that others could have the impudence to distort the truth so infamously. Even though the facts which prove this to be so may be brought clearly to their minds, they will still doubt and waver and will continue to think that there may be some other explanation. For the grossly impudent lie always leaves traces behind it, even after it has been nailed down, a fact which is known to all expert liars in this world and to all who conspire together in the art of lying.

That is of course rather painful for those involved. One should not as a rule reveal one's secrets, since one does not know if and when one may need them again. The essential English leadership secret does not depend on particular intelligence. Rather, it depends on a remarkably stupid thick-headedness. The English follow the principle that when one lies, one should lie big, and stick to it. They keep up their lies, even at the risk of looking ridiculous.

Psychologists and sociologists show us that people will rationalize what their leaders are doing, even when it makes no sense ....

Sociologists from four major research institutions investigated why so many Americans believed that Saddam Hussein was behind 9/11, years after it became obvious that Iraq had nothing to do with 9/11.

The researchers found, as described in an article in the journal Sociological Inquiry (and re-printed by Newsweek):

Many Americans felt an urgent need to seek justification for a war already in progress

Rather than search rationally for information that either confirms or disconfirms a particular belief, people actually seek out information that confirms what they already believe.

"For the most part people completely ignore contrary information."

"The study demonstrates voters' ability to develop elaborate rationalizations based on faulty information"

People get deeply attached to their beliefs, and form emotional attachments that get wrapped up in their personal identity and sense of morality, irrespective of the facts of the matter.

"We refer to this as 'inferred justification, because for these voters, the sheer fact that we were engaged in war led to a post-hoc search for a justification for that war.

"People were basically making up justifications for the fact that we were at war"

"They wanted to believe in the link [between 9/11 and Iraq] because it helped them make sense of a current reality. So voters' ability to develop elaborate rationalizations based on faulty information, whether we think that is good or bad for democratic practice, does at least demonstrate an impressive form of creativity.

An article yesterday in Alternet discussing the Sociological Inquiry article helps us to understand that the key to people's active participation in searching for excuses for actions by the big boys is fear:

Subjects were presented during one-on-one interviews with a newspaper clip of this Bush quote: "This administration never said that the 9/11 attacks were orchestrated between Saddam and al-Qaeda."

The Sept. 11 Commission, too, found no such link, the subjects were told.

"Well, I bet they say that the commission didn't have any proof of it," one subject responded, "but I guess we still can have our opinions and feel that way even though they say that."

Reasoned another: "Saddam, I can't judge if he did what he's being accused of, but if Bush thinks he did it, then he did it."

Others declined to engage the information at all. Most curious to the researchers were the respondents who reasoned that Saddam must have been connected to Sept. 11, because why else would the Bush Administration have gone to war in Iraq?

The desire to believe this was more powerful, according to the researchers, than any active campaign to plant the idea.

"That kind of puts the idea out there, but what people then do with the idea ... " he said. "Our argument is that people aren't just empty vessels. You don't just sort of open up their brains and dump false information in and they regurgitate it. They're actually active processing cognitive agents"...

The alternate explanation raises queasy questions for the rest of society.

"I think we'd all like to believe that when people come across disconfirming evidence, what they tend to do is to update their opinions," said Andrew Perrin, an associate professor at UNC and another author of the study...

"The implications for how democracy works are quite profound, there's no question in my mind about that," Perrin said. "What it means is that we have to think about the emotional states in which citizens find themselves that then lead them to reason and deliberate in particular ways."

Evidence suggests people are more likely to pay attention to facts within certain emotional states and social situations. Some may never change their minds. For others, policy-makers could better identify those states, for example minimizing the fear that often clouds a person's ability to assess facts ...

The Alternet article links to a must-read interview with psychology professor Sheldon Solomon, who explains:

A large body of evidence shows that momentarily [raising fear of death], typically by asking people to think about themselves dying, intensifies people's strivings to protect and bolster aspects of their worldviews, and to bolster their self-esteem. The most common finding is that [fear of death] increases positive reactions to those who share cherished aspects of one's cultural worldview, and negative reactions toward those who violate cherished cultural values or are merely different.

I would argue that the fact that the governments of the world have given trillions to the giant banks has invoked the same mental process - and susceptibility to propaganda -as the war in Iraq.

Specifically, many people assume that because the government has launched a war to prop up the giant banks, it must have a good reason for doing so.

Why else would trillions in taxpayer dollars be thrown at the giant banks? Why else would the government say that saving the big boys is vital?

And I would argue that the fear of another Great Depression (an economic death, if you will) is analogous to the fear of death triggered in many Americans by 9/11.

This creates a regression towards old-fashioned thinking about such things as banks and the financial system, even though the giant banks actually do very little traditional banking these days.

In other words, the big lie appears to be as effective in financial as in military warfare.

Numerous people have asked us who writes Washington's Blog and why we write under a pen name.

In fact, some of the leading writers have used pen names.

As one of the best financial writers - Tyler Durden of Zero Hedge - points out (edited slightly for readability):

Though often maligned (typically by those frustrated by an inability to engage in ad hominem attacks), anonymous speech has a long and storied history in the United States. Used by the likes of Mark Twain (aka Samuel Langhorne Clemens) to criticize common ignorance, and perhaps most famously by Alexander Hamilton, James Madison and John Jay (aka publius) to write the Federalist Papers, we think ourselves in good company in using one or another nom de plume.

Particularly in light of an emerging trend against vocalizing public dissent in the United States, we believe in the critical importance of anonymity and its role in dissident speech.

Like the Economist magazine, we also believe that keeping authorship anonymous moves the focus of discussion to the content of speech and away from the speaker - as it should be. We believe not only that you should be comfortable with anonymous speech in such an environment, but that you should be suspicious of any speech that isn't.

I am a busy professional, a former adjunct professor, an American and a family man. I am post-partisan: I don't think either the Republican or Democratic parties represent the interests of the people as opposed to the big banks, major corporations, and the military-industrial complex.

But my background is less important than the fact that I provide links to document everything I say, so you can check its accuracy for yourself.

The escalating debt crisis on the eurozone periphery is starting to contaminate the creditworthiness of Germany and the core states of monetary union.

Credit default swaps (CDS) measuring risk on German, French and Dutch bonds have surged over recent days, rising significantly above the levels of non-EMU states in Scandinavia.

"Germany cannot keep paying for bail-outs without going bankrupt itself," said Professor Wilhelm Hankel, of Frankfurt University. "This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings."

The refrain was picked up this week by German finance minister Wolfgang Schäuble. "We're not swimming in money, we're drowning in debts," he told the Bundestag.

While Germany's public and private debt is not extreme, it is very high for a country on the cusp of an acute ageing crisis. Adjusted for demographics, Germany is already one of the most indebted nations in the world.

As the following Reuters chart shows (based on information provided by BIS), France and Germany are the largest holder of Greek debt:

As The Street notes, France and Germany are also greatly exposed to Portugal and Spain:

France's banking sector has the second-largest exposure to Portugal and Spain debt loads, after Germany, according to the BIS.

European banks have more at-risk assets in Portugal and Spain than in Greece. European lenders are holding Portugal debt issues of $240.5 billion -- including $47.4 billion by German banks and $44.9 billion by French firms, according to BIS figures from the end of 2009 quoted in a Bloomberg report.

And as Tyler Durden points out, France Germany and the UK are getting hit with wider credit default swap spreads:

With a stunning $630 million, $558 million and $370 million in net notional derisking, France, UK and Germany are the top three most active recipients in negative bets in the prior week, not just in sovereigns but in all names...

Zero Hedge's outside bet to be the first core country to blow up, thanks to its massive PIIGS exposure, France, finally made the top spot in net derisking, with $629 million in net notional, or 189 contracts. The smart money is now massively betting that Europe's core is done for; as the PIIGS have demonstrated, the blow out in spreads for the core trifecta can not be far behind.

Given that central bankers have - for several years - focused on credit default swaps as the most important economic indicator (see this and this), widening spreads are a bad sign, indeed.

U.S. banks hold about $133 billion in debt from Ireland, Spain, Portugal and Greece ....

***

A full-blown debt crisis in Europe could ... also send the euro plunging against the dollar, making the greenback stronger on world markets and undermining the efforts of the Obama administration to boost U.S. exports overseas.

"For now, the U.S. is kind of insulated," said Simon White, a partner at the London-based research firm Variant Perception. But whether it stays that way, he said, "depends on how deep the crisis goes."

Americans will not be spared if there's a recession in Europe, even if U.S. bank exposure to European government debt is relatively limited.

The European Union is the second largest market for U.S. exports, behind only Canada. The EU bought about $175 billion in U.S. goods in the first three quarters of this year. That's up about 8% from a year ago.

So worsening problems in Europe will clearly be a drag on the U.S. as well.

But the question of what country the "contagion" might spread to next is really the wrong question altogether.

The real question is whether the wealth of the people around the world will continue to be shoveled into the bottomless pit of debts held by the big banks, or whether the people will prevail and the giant banks and bondholders will be forced to take a haircut. See this, this and this.

Today the Irish Government sold its citizens into debt slavery by agreeing to guarantee stupid loans made by German, British, and US banks.

***

Why the average Irish citizen should have to bail out foreign bondholders is beyond me, but I do note that the same happened in the US with taxpayers footing an enormous bill for Fannie Mae, Freddie Mac, and AIG.

It is now common knowledge that there is a potential domino effect of European sovereign debt contagion in roughly the following order:

Greece → Ireland → Portugal → Spain → Italy → UK

While some people have been writing about this for well over a year, many others have joined the party late (there are now over 600,000 hits from a Google search discussing this topic.)

It is also now common knowledge that while Greece and Ireland have relatively small economies, there will be real trouble if the Spanish domino falls.

Iceland has the world's 112th biggest economy, Ireland the 38th, and Portugal the 36th. In contrast, Spain has the world's 9th biggest economy, Italy the 7th and the UK the6th. A failure by one of the latter 3 would be devastating for the world economy.

But the real nightmare domino is Spain. Roubini refers to the Spanish debt problems as "the elephant in the room".

"You can try to ring fence Spain. And you can essentially try to provide financing officially to Ireland, Portugal, and Greece for three years. Leave them out of the market. Maybe restructure their debt down the line."

"But if Spain falls off the cliff, there is not enough official money in this envelope of European resources to bail out Spain. Spain is too big to fail on one side—and also too big to be bailed out."

With Spain, the first problem is the size of its public debt: €1 trillion. (Greece, by contrast, has €300 of public debt.) Spain also has €1 trillion in private foreign liabilities.

And for problems of that magnitude, there simply are not enough resources—governmental or super-sovereign—to go around.

And as I've previously pointed out, Germany and France - the world's 4th and 5th largest economies - have the greatest exposure to Portuguese and Spanish debt. For more on the interconnections between Euro economies adding to the risk of contagion, see this and this.

While it is tempting to assume that the Eurozone bailouts mean that creditor nations which have managed their economies well and saved huge amounts of excess reserves which they lend out, Sean Corrigon points out that the European bailouts are a Ponzi scheme:

Under the rules of this multi-trillion shell game, the sovereigns guarantee the ECB which funds the banks which buy the government debt which provides for everyone else's guarantees.

(America is no different: Bill Gross, Nouriel Roubini, Laurence Kotlikoff, Steve Keen, Michel Chossudovsky and the Wall Street Journal all say that America is running a giant Ponzi scheme as well. And both America and Europe are trying to cover up the insolvency of their banks by running faux stress tests.)

It didn't have to be like this. The European nations did not have to sacrifice themselves for the sake of their big banks.

"We have decided to socialize the private losses of the banking system.

***

Roubini believes that further attempts at intervention have only increased the magnitude of the problems with sovereign debt. He says, "Now you have a bunch of super sovereigns— the IMF, the EU, the eurozone—bailing out these sovereigns."

Essentially, the super-sovereigns underwrite sovereign debt—increasing the scale and concentrating the problems.

Roubini characterizes super-sovereign intervention as merely kicking the can down the road.

He says wryly: "There's not going to be anyone coming from Mars or the moon to bail out the IMF or the Eurozone."

But, despite the paper shuffling of debt at the national level—and at the level of supranational entities—reality ultimately intervenes: "So at some point you need restructuring. At some point you need the creditors of the banks to take a hit —otherwise you put all this debt on the balance sheet of government. And then you break the back of government—and then government is insolvent."

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

***

But They Had No Choice ... Did They?

But nations had no choice but to bail out their banks, did they?

Well, actually, they did.

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach (as are other central bankers).

Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

BIS slammed the easy credit policy of the Fed and other central banks, the failure to regulate the shadow banking system, "the use of gimmicks and palliatives", and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts "will only make things worse".

Remember, America wasn't the only country with a housing bubble. The world's central bankers let a global housing bubble development. As I noted in December 2008:

... The bubble was not confined to the U.S. There was a worldwide bubble in real estate.

And the bubble in commercial real estate is also bursting world-wide. See this.

***

BIS also cautioned that bailouts could harm the economy (as did the former head of the Fed's open market operations). Indeed, the bailouts create a climate of moral hazard which encourages more risky behavior. Nobel prize winning economist George Akerlof predicted in 1993 that credit default swaps would lead to a major crash, and that future crashes were guaranteed unless the government stopped letting big financial players loot by placing bets they could never pay off when things started to go wrong, and by continuing to bail out the gamblers.

These truths are as applicable in Europe as in America. The central bankers have done the wrong things. They haven't fixed anything, but simply transferred the cancerous toxic derivatives and other financial bombs from the giant banks to the nations themselves.

Wednesday, November 24, 2010

Well-known British economic writer Jeremy Warner said yesterday that the European stress tests were a sham:

European stress tests weren't worth the paper they were written on ...

Most of us said at the time that the tests had been designed for banks to pass, yet the fact is that it is now hard to believe they took place at all. Conditions have no where near deteriorated as far as the tests had assumed, yet still Allied Irish looks essentially bust. In other words the tests were a lie.

If the Irish stress tests were a sham, what about the rest of the eurozone?

Concerns about the health of most large institutions have decreased, though investors remain nervous about the extent of losses banks face if they are required to repurchase flawed mortgages and mortgage-related investments. As part of its review, the Fed will require banks to assess their exposure to so-called "put-backs" of mortgages

Banks will also have to come up with their own set of metrics, including the ability to withstand "very severe" economic and financial-market events, the Fed said.

Some Republican congressmen are trying to take away the goal of ensuring full employment from the Fed. See this and this.

Conservatives argue that the relationship between inflation and unemployment - as represented in the Phillips Curve - is false, and therefore the rationale behind the dual mandate makes no sense. See this, this and this.

But I think that all of their arguments pro or anti the Fed's dual mandate are missing the point.

Specifically, the Fed's dual mandate was created more than 30 years ago, in 1978.

The Fed has had this full employment mandate all throughout this economic crisis. But it is indisputable that the Fed's actions have been increasing unemployment. See this and this. Indeed, John Williams puts the current real unemployment rate at around 23%.

The Fed had the mandate in 2007, 2008, 2009 and 2010 ... but it acted to save the big banks instead of the American worker.

And yet the Fed has been given more and more power - even though it has been increasing unemployment ... and even though the American people already thought the Fed hadtoo much power. See this, this and this.

Protecting riders on mass-transit systems from terrorist attacks will be as high a priority as ensuring safe air travel, the new head of the Transportation Security Administration promises.

In his first interview since taking over the TSA, former FBI deputy director John Pistole told USA TODAY that some terrorists consider subway and rail cars an easier target than heavily secured planes. "Given the list of threats on subways and rails over the last six years going on seven years, we know that some terrorist groups see rail and subways as being more vulnerable because there's not the type of screening that you find in aviation," he said. "From my perspective, that is an equally important threat area."

Indeed, as Forbes' Andy Greenberg notes, mobile backscatter x-ray scanners are already being mounted in vans and used on American streets:

The same technology, capable of seeing through clothes and walls, has also been rolling out on U.S. streets.

***It would also seem to make the vans mobile versions of the same scanning technique that’s riled privacy advocates as it’s been deployed in airports around the country.

***

“It’s no surprise that governments and vendors are very enthusiastic about [the vans],” says Marc Rotenberg, executive director of EPIC. “But from a privacy perspective, it’s one of the most intrusive technologies conceivable.”

The skirmish began when Pyongyang [i.e. North Korea] warned the South to halt military drills in the area, according to South Korean officials. When Seoul [i.e. South Korea] refused and began firing artillery into disputed waters, albeit away from the North Korean shore, the North retaliated by bombarding the small island of Yeonpyeong, which houses South Korean military installations....

In addition, the two South Koreans killed were marines, not civilians, stationed in a military town.

Obviously, firing artillery into the water and actually killing people are very different, and I am in no way defending North Korea or its crazy leader. I am simply trying to point out that the headlines can't be taken in a vacuum.

Cantona is calling for Europeans to pull their money out of banks on December 7th:

I don't think we can be entirely happy seeing such misery around us. Unless you live in a pod. But then there is a chance... there is something to do. Nowadays what does it mean to be on the streets? To demonstrate? You swindle yourself. Anyway, that's not the way any more.

We don't pick up weapons to kill people to start the revolution. The revolution is really easy to do these days. What's the system? The system is built on the power of the banks. So it must be destroyed through the banks.

This means that the three million people with their placards on the streets, they go to the bank and they withdraw their money and the banks collapse. Three million, 10 million people, and the banks collapse and there is no real threat. A real revolution.

We must go to the bank. In this case there would be a real revolution. It's not complicated; instead of going on the streets and driving kilometres by car you simply go to the bank in your country and withdraw your money, and if there are a lot of people withdrawing their money the system collapses. No weapons, no blood, or anything like that.

It's not complicated and in this case they will listen to us in a different way.

This would be like a well-known retired American athlete - like Michael Jordan, Joe Montana or Willie Mays - calling for concerted political action.

Indeed, Cantona's call for action is starting to go viral. See this, this and this.

Saturday, November 20, 2010

Ben Bernanke has said that the Fed is trying to promote inflation, increase lending, reduce unemployment, and stimulate the economy.

However, the Fed has arguably - to some extent - been working against all of these goals.

For example, as I reported in March, the Fed has been paying the big banks high enough interest on the funds which they deposit at the Fed to discourage banks from making loans. Indeed, the Fed has explicitly stated that - in order to prevent inflation - it wants to ensure that the banks don't loan out money into the economy, but instead deposit it at the Fed:

Why is M1 crashing? [the M1 money multiplier basically measures how much the money supply increases for each $1 increase in the monetary base, and it gives an indication of the "velocity" of money, i.e. how quickly money is circulating through the system]

Because the banks continue to build up their excess reserves, instead of lending out money:

The Federal Reserve Banks pay interest on required reserve balances--balances held at Reserve Banks to satisfy reserve requirements--and on excess balances--balances held in excess of required reserve balances and contractual clearing balances.

The New York Fed itself said in a July 2009 staff report that the excess reserves are almost entirely due to Fed policy:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1.1 Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

Why are banks holding so many excess reserves? What do the data in Figure 1 tell us about current economic conditions and about bank lending behavior? Some observers claim that the large increase in excess reserves implies that many of the policies introduced by the Federal Reserve in response to the financial crisis have been ineffective. Rather than promoting the flow of credit to firms and households, it is argued, the data shown in Figure 1 indicate that the money lent to banks and other intermediaries by the Federal Reserve since September 2008 is simply sitting idle in banks’ reserve accounts. Edlin and Jaffee (2009), for example, identify the high level of excess reserves as either the “problem” behind the continuing credit crunch or “if not the problem, one heckuva symptom” (p.2). Commentators have asked why banks are choosing to hold so many reserves instead of lending them out, and some claim that inducing banks to lend their excess reserves is crucial for resolving the credit crisis.

This view has lead to proposals aimed at discouraging banks from holding excess reserves, such as placing a tax on excess reserves (Sumner, 2009) or setting a cap on the amount of excess reserves each bank is allowed to hold (Dasgupta, 2009). Mankiw (2009) discusses historical concerns about people hoarding money during times of financial stress and mentions proposals that were made to tax money holdings in order to encourage lending. He relates these historical episodes to the current situation by noting that “[w]ith banks now holding substantial excess reserves, [this historical] concern about cash hoarding suddenly seems very modern.”

[In fact, however,] the total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions.

The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves depicted in Figure 1 reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.

This conclusion may seem strange, at first glance, to readers familiar with textbook presentations of the money multiplier.

We are paying interest on excess reserves, which we can use to help provide a floor for the federal funds rate, as it does for other central banks, even if declines in lending or open market operations are not sufficient to bring reserves down to the desired level.

Because we can now pay interest on excess reserves, we can raise short-term interest rates even with an extraordinarily large volume of reserves in the banking system. Increasing the rate we offer to banks on deposits at the Federal Reserve will put upward pressure on all short-term interest rates.

As the Minneapolis Fed's research consultant, V. V. Chari, wrote this month:

Currently, U.S. banks hold more than $1.1 trillion of reserves with the Federal Reserve System. To restrict excessive flow of reserves back into the economy, the Fed could increase the interest rate it pays on these reserves. Doing so would not only discourage banks from draining their reserve holdings, but would also exert upward pressure on broader market interest rates, since only rates higher than the overnight reserve rate would attract bank funds. In addition, paying interest on reserves is supported by economic theory as a means of reducing monetary inefficiencies, a concept referred to as “the Friedman rule.”

And the conclusion to the above-linked New York Fed article states:

We also discussed the importance of paying interest on reserves when the level of excess reserves is unusually high, as the Federal Reserve began to do in October 2008. Paying interest on reserves allows a central bank to maintain its influence over market interest rates independent of the quantity of reserves created by its liquidity facilities. The central bank can then let the size of these facilities be determined by conditions in the financial sector, while setting its target for the short-term interest rate based on macroeconomic conditions. This ability to separate monetary policy from the quantity of bank reserves is particularly important during the recovery from a financial crisis. If inflationary pressures begin to appear while the liquidity facilities are still in use, the central bank can use its interest-on-reserves policy to raise interest rates without necessarily removing all of the reserves created by the facilities.

As the NY Fed explains in more detail:

The central bank paid interest on reserves to prevent the increase in reserves from driving market interest rates below the level it deemed appropriate given macroeconomic conditions. In such a situation, the absence of a money-multiplier effect should be neither surprising nor troubling.

Is the large quantity of reserves inflationary?

Some observers have expressed concern that the large quantity of reserves will lead to an increase in the inflation rate unless the Federal Reserve acts to remove them quickly once the economy begins to recover. Meltzer (2009), for example, worries that “the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain.” Feldstein (2009) expresses similar concern that “when the economy begins to recover, these reserves can be converted into new loans and faster money growth” that will eventually prove inflationary. Under a traditional operational framework, where the central bank influences interest rates and the level of economic activity by changing the quantity of reserves, this concern would be well justified. Now that the Federal Reserve is paying interest on reserves, however, matters are different.

When the economy begins to recover, firms will have more profitable opportunities to invest, increasing their demands for bank loans. Consequently, banks will be presented with more lending opportunities that are profitable at the current level of interest rates. As banks lend more, new deposits will be created and the general level of economic activity will increase. Left unchecked, this growth in lending and economic activity may generate inflationary pressures. Under a traditional operating framework, where no interest is paid on reserves, the central bank must remove nearly all of the excess reserves from the banking system in order to arrest this process. Only by removing these excess reserves can the central bank limit banks’ willingness to lend to firms and households and cause short-term interest rates to rise.

Paying interest on reserves breaks this link between the quantity of reserves and banks’ willingness to lend. By raising the interest rate paid on reserves, the central bank can increase market interest rates and slow the growth of bank lending and economic activity without changing the quantity of reserves. In other words, paying interest on reserves allows the central bank to follow a path for short-term interest rates that is independent of the level of reserves. By choosing this path appropriately, the central bank can guard against inflationary pressures even if financial conditions lead it to maintain a high level of excess reserves.

This logic applies equally well when financial conditions are normal. A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly regarding the operation of the payments system. For example, when banks hold more reserves they tend to rely less on daylight credit from the central bank for payments purposes. They also tend to send payments earlier in the day, on average, which reduces the likelihood of a significant operational disruption or of gridlock in the payments system. To capture these benefits, a central bank may choose to create a high level of reserves as a part of its normal operations, again using the interest rate it pays on reserves to influence market interest rates.

Because financial conditions are not "normal", it appears that preventing inflation seems to be the Fed's overriding purpose in creating conditions ensuring high levels of excess reserves.

The multiplier's decline "corresponds so exactly to the expansion of the Fed's balance sheet," says Constance Hunter, economist at hedge-fund firm Galtere. "It hits at the core of the problem in a credit crisis. Until [the multiplier] expands, we can't get sustainable growth of credit, jobs, consumption, housing. When the multiplier starts to go back up toward 1.8, then we know the psychological logjam has begun to break."

***

It's not just the Fed. The NY Fed report notes:

Most central banks now pay interest on reserves.

Robert D. Auerbach - an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and subsequently Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin - argues that the Fed should slowly reduce the interest paid on reserves so as to stimulate the economy.

The stimulative effects of QE2 may be small and the costs may be large. One of these costs will be the payment of billions of dollars by taxpayers to the banks which currently hold over 50 percent of the monetary base, over $1 trillion in reserves. The interest payments are an incentive for banks to hold reserves rather than make business loans. If market interest rates rise, the Federal Reserve may be required to increase these interest payments to prevent the huge amount of bank reserves from flooding the economy. They should follow a different policy that benefits taxpayers and increases the incentive of banks to make business loans as I have previously suggested.

Immediately after the recession took a dramatic dive in September 2008, the Bernanke Fed implemented a policy that continues to further damage the incentive for banks to lend to businesses. On October 6, 2008 the Fed's Board of Governors, chaired by Ben Bernanke, announced it would begin paying interest on the reserve balances of the nation's banks, major lenders to medium and small size businesses.

You don't need a Ph.D. economist to know that if you pay banks ¼ percent risk free interest to hold reserves that they can obtain at near zero interest, that would be an incentive to hold the reserves. The Fed pumped out huge amounts of money, with the base of the money supply more than doubling from August 2008 to August 2010, reaching $1.99 trillion. Guess who has over half of this money parked in cold storage? The banks have $1.085 trillion on reserves drawing interest, The Fed records show they were paid $2.18 billion interest on these reserves in 2009.

A number of people spoke about the disincentive for bank lending embedded in this policy including Chairman Bernanke.

***Jim McTague, Washington Editor of Barrons, wrote in his February 2, 2009 column, "Where's the Stimulus:" "Increasing the supply of credit might help pump up spending, too. University of Texas Professor Robert Auerbach an economist who studied under the late Milton Friedman, thinks he has the makings of a malpractice suit against Federal Reserve Chairman Ben Bernanke, as the Fed is holding a record number of reserves: $901 billion in January as opposed to $44 billion in September, when the Fed began paying interest on money commercial banks parked at the central bank. The banks prefer the sure rate of return they get by sitting in cash, not making loans. Fed, stop paying, he says."

Shortly after this article appeared Fed Chairman Bernanke explained: "Because banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed, the interest rate the Fed pays on bank reserves should help to set a floor on the overnight interest rate." (National Press Club, February 18, 2009) That was an admission that the Fed's payment of interest on reserves did impair bank lending. Bernanke's rationale for interest payments on reserves included preventing banks from lending at lower interest rates. That is illogical at a time when the Fed's target interest rate for federal funds, the small market for interbank loans, was zero to a quarter of one percent. The banks would be unlikely to lend at negative rates of interest -- paying people to take their money -- even without the Fed paying the banks to hold reserves.

The next month William T. Gavin, an excellent economist at the St. Louis Federal Reserve, wrote in its March\April 2009 publication: "first, for the individual bank, the risk-free rate of ¼ percent must be the bank's perception of its best investment opportunity."

The Bernanke Fed's policy was a repetition of what the Fed did in 1936 and 1937 which helped drive the country into a second depression. Why does Chairman Bernanke, who has studied the Great Depression of the 1930's and has surely read the classic 1963 account of improper actions by the Fed on bank reserves described by Milton Friedman and Anna Schwartz, repeat the mistaken policy?

As the economy pulled out of the deep recession in 1936 the Fed Board thought the U.S. banks had too much excess reserves, so they began to raise the reserves banks were required to hold. In three steps from August 1936 to May 1937 they doubled the reserve requirements for the large banks (13 percent to 26 percent of checkable deposits) and the country banks (7 percent to 14 percent of checkable deposits).

Friedman and Schwartz ask: "why seek to immobilize reserves at that time?" The economy went back into a deep depression. The Bernanke Fed's 2008 to 2010 policy also immobilizes the banking system's reserves reducing the banks' incentive to make loans.

This is a bad policy even if the banks approve. The correct policy now should be to slowly reduce the interest paid on bank reserves to zero and simultaneously maintain a moderate increase in the money supply by slowly raising the short term market interest rate targeted by the Fed. Keeping the short term target interest rate at zero causes many problems, not the least of which is allowing banks to borrow at a zero interest rate and sit on their reserves so they can receive billions in interest from the taxpayers via the Fed. Business loans from banks are vital to the nations' recovery.

The fact that the Fed is suppressing lending and inflation at a time when it says it is trying to encourage both shows that the Fed is saying one thing and doing something else entirely.

I have previously pointed out numerous other ways in which the Fed is working against its stated goals, such as:

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